Reserve currency

Reserve currency

Subject: Economy

Section: External sector

Context:

A crypto platform’s pledge to amass $10 billion worth of bitcoin to back its own ‘stable- coin’ is firing up the market. It’s part of a wider movement to crown bitcoin as the reserve currency of a new age.

Reserve currency?

A reserve currency is a foreign currency or precious metal that is held in large quantities; it may be held by a country’s government, central bank, or other monetary authority. It is used for participating in the global economy, such as through international transactions or investments.

• A reserve currency reduces exchange rate risk since there’s no need for a country to exchange its currency for the reserve currency to do trade.
• Reserve currency helps facilitate global transactions, including investments and international debt obligations.
• A large percentage of commodities are priced in the reserve currency, causing countries to hold this currency to pay for these goods.

Before the mid-20th century, reserves were mostly gold and silver. Modern reserves are generally made up of strong foreign currencies. Many of them are specifically designated as reserve currencies by the International Monetary Fund (IMF).

Starting in the mid-20th century, the U.S. dollar was set as the international reserve currency. Backed by the safest of all paper assets, U.S. Treasuries, the US dollar is still the most redeemable currency for facilitating world commerce. 

The U.S. dollar isn’t the only reserve currency designated by the IMF and other global organizations. The euro, Chinese renminbi, Japanese yen, and British pound sterling are all popular as reserve currencies.

Characteristics: 

• Availability– has the depth and liquidity to allow for reliable and efficient international transactions.
• Acceptability-can be freely and easily exchanged for other currencies.
• Stability–held by many monetary authorities and institutions, in significant amounts.

Factors that make a currency useful as a reserve currency:

• The size of the economy in the country where that currency comes from
• International integration of that economy.
• How open its financial markets are
• The currency’s convertibility
• Whether it is used as a regional or international currency peg
• Domestic macroeconomic policies